Dollar Stabilizes in the Wake of Powell Comments

  • The dollar has stabilized after the initial sell-off in the wake of Powell’s speech
  • Markets might be reassessing the knee-jerk reaction to Powell
  • Fed messaging could use some work; FOMC minutes will be released today
  • Oil prices have slid to new lows for this move today
  • Germany reports preliminary November CPI today, followed by the eurozone reading Friday
  • Banco de Mexico releases its monetary policy minutes

The dollar is mostly firmer against the majors in the wake of Powell’s comments.  Yen and Aussie are outperforming, while sterling and Stockie are underperforming.  EM currencies are mostly firmer.  TRY and INR are outperforming, while RON and PLN are underperforming.  MSCI Asia Pacific was up 0.7%, with the Nikkei rising 0.4%.  MSCI EM is up 0.5% so far today, with the Shanghai Composite falling 1.3%.  Euro Stoxx 600 is up 0.3% near midday, while US futures are pointing to a lower open.  The US 10-year yield is down 5 bp at 3.01%.  Commodity prices are mostly lower, with Brent oil down 1.2%, copper down 0.4%, and gold up 0.3%.

The dollar has stabilized after the initial sell-off in the wake of Powell’s speech yesterday.  EM FX is extending its gains but within the majors, only the yen has been able to build on its gains today.  The euro ran out of steam near $1.14, likewise for sterling near $1.2850.  However, until the markets’ Fed expectations shift away from the extreme dovishness currently, we think the dollar will likely have trouble rallying much.  Of course, global equity markets loved the news overnight but here too, the momentum is flagging as US futures are showing a lower open.  What gives?

Markets might be reassessing the knee-jerk reaction to Powell.  After saying back on October 3 that “we’re a long way from neutral,” Powell said yesterday that we are “just below” the broad range of estimates for the neutral rate now.  This was taken as a major dovish shift, but we think markets need to recognize a very subtle but important distinction here.  In the September Fed Dot Plots, the range of Fed estimates for the longer-term neutral rate was a rather broad 2.5-3.5%.  With the current Fed Funds target range at 2.00-2.25%, Powell was simply stating the obvious.

Yet markets were clearly biased to read these comments in a dovish way.  We continue to believe that this is an incorrect read.  Economic conditions have not shifted that much over the past few weeks, as the US economy continues to grow above trend and the labor market is near full employment.  US financial conditions (as measured by the Chicago Fed) are near record looseness despite the Fed’s eight hikes to date.  Until financial conditions tighten more, we fear that the Fed is falling behind the curve.  A dovish message is not the right message to markets, in our view.

To state the obvious, Fed messaging could use some work.  Yes, Powell is still fairly new to the job and is still learning the ropes.  Still, he should have realized that markets were likely to take his comments in a dovish way.  And the fact that Powell said this a day after Trump’s criticism is bad optics.  We’re not saying Powell bent to Trump’s will, but even the slightest appearance of doing so is not good.  The Fed has always prided itself on its independence and we are disappointed that this could now be called into question.

FOMC minutes will be released today.  After Powell’s bombshell yesterday, these minutes have basically been rendered moot.  Still, given the markets leaning these days, we suspect they will be looking to latch onto anything remotely dovish in these minutes.

Market expectations for the December FOMC were unaffected, with WIRP showing nearly 80% odds of a hike then.  The adjustment has been seen further out as the implied yield on the January 2020 Fed Funds futures contract has sunk to 2.70%, the lowest since September 6.  This suggests only one hike in 2019 after the widely expected hike next month.  It will be very interesting to see if the December Dot Plots will show any downward movement from the current three hikes signaled for 2019.

During the North American session, US personal income and spending for November will be reported.  Included in that report is the core PCE deflator, which is expected to tick down to 1.9% y/y after spending several months at the Fed’s 2% target.  Also, out today will be weekly jobless claims and October pending home sales.

Oil prices have slid to new lows for this move today.  Yesterday, the US reported a much larger than expected build in crude oil inventories, which is adding to the gloom.  In addition, Russian President Putin said current prices around $60 are “absolutely fine.”  This would seem to downplay any chance of a large-scale coordinated cut in output.  Until we do see one that involves both the Saudis and Russia, Brent is on track to test the June 2017 low near 44.35 and WTI to test its June 2017 low near 42.05.

Germany reports preliminary November CPI today, followed by the eurozone reading Friday.  The former is seen falling to 2.4% y/y from 2.5% in October (to 2.3% from 2.4% for the EU harmonized measure), while the latter is seen falling to 2.0% y/y from 2.2% in October.  Some German states have already reported slower CPI inflation and we see some downside risks to the national reading.  Further weakness in the eurozone readings will cast doubt on the ECB’s ability to hike rates next year.

Japan reported stronger than expected October retail sales.  Sales rose 1.2% m/m, triple the expected 0.4% gain.  Also, the September reading was revised up to 0.1% from -0.1% previously.  Yet the BOJ will remain concerned and we see no policy impact.  Overnight, Japan will report October jobs, IP, and November Tokyo CPI.

EM FX has benefitted from the perceived Fed dovishness.  Yet we can’t get too excited knowing that US-China trade tensions remain high and global growth continues to slow.  EM assets may see some further near-term gains, but the global outlook remains challenging.

Banco de Mexico releases its monetary policy minutes.  After restarting the tightening cycle with a 25 bp hike to 8.0% at that meeting, markets will be looking for clues as to future policy.  We expect further tightening in 2019 but see no change at the next meeting December 20.  The bank shaved its growth forecasts in its quarterly inflation report released yesterday.  Growth is seen between 2.0-2.4% this year vs. 2.0-2.6% previously and between 1.7-2.7% next year vs. 1.8-2.8% previously.